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The New Nike


In many ways, the sleek, four-story building that houses Nike Inc.'s (NKE) Innovation Kitchen is a throwback to the company's earliest days. Located on the ground floor of the Mia Hamm building on Nike's 175-acre headquarters campus in Beaverton, Ore., the Kitchen is where Nike cooked up the shoes that made it the star of the $35 billion athletic footwear industry. In this think tank for sneakers, designers find inspiration in everything from Irish architecture to the curving lines of a Stradivarius violin. One wall displays models of every Air Jordan ever made, while low-rise cubicles are littered with sketches of new shoes. The Kitchen is off limits to most visitors and even to most Nike employees. The sign on the door says, only half in jest: "Nobody gets in to see the cooks. Not nobody. Not no how."

This is where, nearly 20 years ago, Nike star designer Tinker Hatfield came up with the Air Jordan -- the best-selling sports shoe of all time. Right now, Hatfield and his team are tallying the results of the Athens 2004 Olympic Games. Hatfield and his design geeks produced an array of superfast sneakers for the Games, including the sleek track spike called Monsterfly for sprinters and the Air Zoom Miler for distance runners. As befits a global company, Nike's sponsored athletes hailed from all over the world. They took home a lot of hardware from Athens, including 50 gold medals and dozens more silver and bronze. In the men's 1,500-meter run, for instance, Hicham El Guerrouj of Morocco grabbed gold, Bernard Lagat of Kenya took the silver, and Rui Silva of Portugal won the bronze. All wore the Air Zoom Miler, while U.S. sprinter Shawn Crawford won the 200-meter gold in a pair of Monsterflys. And Nike apparel had its day in the sun, too. The top four finishers in the men's 100-meter race all wore the sign of the Swoosh.

GOING ESTABLISHMENT

The most telling events for Nike didn't take place on the track, however. The brash guerrilla marketer, famous for thumbing its nose at big-time sporting events, was showing a new restraint. Eight years ago in Atlanta, Nike ambushed basketball sponsor Champion (a brand of Sara Lee Corp.) by sneaking giant Swoosh signs into the arena. When the cameras panned the stands, TV audiences saw the Nike logo loud and clear, while Champion had nothing. Nike has even signed up to become an official U.S. Olympic sponsor in four years in Beijing, and it has toned down its anti-Establishment attitude. For good reason: These days, Nike is the Establishment when it comes to global sports marketing. With revenues exceeding $12 billion in fiscal 2004, the company that Philip H. Knight started three decades ago by selling sneakers out of the back of a car at track meets has finally grown up.

The kind of creativity that led Bill Bowerman, the University of Oregon track coach who co-founded the company with Knight, to dream up a new kind of sneaker tread after studying the pattern on his wife's waffle iron, is still revered at Nike. When it comes to the rest of the business, however, it's a whole new ball game. Gone are the days when Nike execs, working on little more than hunches, would do just about anything and spend just about any amount in the quest for publicity and market share. Scott Bedbury, a former Nike marketing chief, recalls pitching his advertising budget to Knight back in 1987. He was asking for a huge increase, from $8 million to $34 million and was prepared to make his case. Instead, Knight asked him the one question he hadn't prepped for: "How do we know you're asking for enough?" That year, Nike spent a jaw-dropping $48 million. The brash innovator of sports marketing may still open the checkbook wide -- as it did when it signed basketball phenom LeBron James to a $90 million endorsement contract last year, but those grand gestures are far fewer at the new Nike.

In the past few years, the company has devoted as much energy to the mundane details of running a business -- such as developing top-flight information systems, logistics, and (yawn) supply-chain management -- as it does to marketing coups and cutting-edge sneaker design. More and more, Nike is searching for the right balance between its creative and its business sides, relying on a newfound financial and managerial discipline to drive growth. "Senior management now has a clear understanding of managing the creative process and bringing it to the bottom line. That's the big difference compared to the past," says Robert Toomey, an equity analyst at RBC Dain Rauscher Inc. in Seattle.

BUSINESSLIKE -- AND UNCOOL?

In the old days, Nike operated pretty much on instinct. It took a guess as to how many pairs of shoes to churn out and hoped it could cram them all onto retailers' shelves. Not anymore. Nike has overhauled its computer systems to get the right number of sneakers to more places in the world more quickly. By methodically studying new markets, it has become a powerhouse overseas -- and in new market segments that it once scorned, such as soccer and fashion. It has also beefed up its management team. And after stumbling with its acquisitions, Nike has learned to manage those brands -- Cole Haan dress shoes, Converse retro-style sneakers, Hurley International skateboard gear, and Bauer in-line and hockey skates -- more efficiently. Indeed, part of Nike's growth strategy is to add to its portfolio of brands.

To many of the Nike faithful, those sorts of changes smacked of heresy. Lebron James is cool. Matrix organization and corporate acquisitions aren't. But cool or not, the new approach is working. In fiscal 2004, ended May 31, Nike showed just how far it had elevated its financial game. It turned in a record year, earning almost $1 billion, 27% more than the year before, on sales that climbed 15%, to $12.3 billion. What's more, orders worldwide were up a healthy 10.7%. In North America orders rose 10% following eight stagnant quarters.

That performance has pleased investors, who now see a company where earnings are less volatile and less fad-driven, yet still growing rapidly enough to spin off lots of cash. In the past fiscal year, Nike's free cash flow totaled $1.2 billion, and its return on invested capital was 22%, up from only 14% four years ago. The company boosted its dividend by 43% last fall and completed a $1 billion share repurchase. It plans to buy back $1.5 billion more in shares over the next four years. The result: Nike stock recently traded at about 78, up 37% in the past year vs. a 9% rise in the Standard & Poor's 500-stock index. The truth is, the onetime corporate rebel is edging toward blue-chip respectability. Who'd have figured?

Nike believes its newfound discipline will enable it to meet its targets of 15% average annual profit growth and revenue growth in the high single digits. Wall Street shares that optimism. Says John J. Shanley, an analyst at Susquehanna Financial Group, an institutional broker in Bala Cynwyd, Pa.: "Nike is probably in the best financial position it has been in in a decade." In fact, some analysts believe Nike is poised to become a $20 billion company by the end of the decade.

That would have seemed laughable just a few years ago -- sales started falling after hitting the $9.6 billion mark in 1998. Even before Nike's superstar endorser and basketball great Michael Jordan retired from the game in 2003, Nike's creative juices seemed to have run dry. Air Jordans at $200 were collecting dust on store shelves as buyers seeking a different look began switching to Skechers (SKX), K-Swiss (KSWS), and New Balance shoes. Nike wrestled with accusations that it exploited Asian factory workers. Ho-hum new sneakers and troubled acquisitions didn't help. Nike, eager to regain its old momentum, bumped up production -- only to end up pushing more sneakers into the market than the customers wanted to buy. As for financial discipline? Well, just consider this: From 1997 to 1999, Nike didn't even have a chief financial officer. "We had a bit of a burning platform," says Donald W. Blair, the executive whom Knight recruited from PepsiCo Inc. (PEP) to fill the position.

It was during those tough times that Phil Knight, who had disengaged from Nike in order to travel and pursue other interests, came back to the company. The year was 1999. Co-founder Bowerman had died, and Nike was floundering. Knight, now 66, needed to set things straight. Standing before thousands of employees at a company meeting, he admitted that the managers who were running the place had failed. And he went on to blame himself. "He said he wasn't as engaged as he should be, and he said there were things he could do better," recalls Steve Miller, Nike's former global sports marketing director, who was there. "I was personally stunned he would be so open about his failings." Knight, whose son died in a scuba diving accident earlier this summer, declined to speak to BusinessWeek.

Knight has been hailed as a visionary for his company's breakthrough design, technology, and marketing prowess. In the 1980s and '90s, Knight forever changed the rules of sports marketing with Nike's huge endorsement contracts and in-your-face advertising. Mixing marketing and pop music is commonplace now. But Nike created a small furor in 1987 when it used the Beatles' Revolution in ads to sell cross-training sneakers.

Still, when his iconoclastic company faltered, Knight looked beyond the technology and marketing antics that had served it well in the past. Upon his return to the company five years ago, his first order of business was to put together a new executive team. Knight drew on some Nike veterans, executives who carry the heritage and culture of Nike's early years. But he also recruited some key players from far outside Nike and its industry. CFO Blair, who came aboard in 1999, was lured from Pepsi, while Mindy F. Grossman was plucked from Polo Ralph Lauren Corp. (RL) the next year with the mission of redefining Nike's $3.5 billion global apparel business. The-day-to-day boss, Chief Operating Officer Thomas E. Clarke, now runs Nike's new business ventures division.

Knight made his boldest management move in 2001, when he named two longtime Nike insiders, creative brand and design wonk Mark G. Parker and operations maven Charles D. Denson, as co-presidents. With Grossman and Blair providing an outsider's perspective and with Parker and Denson steeped in the company's culture, Knight hoped to achieve a balance between the old and the new, the creative and the financially responsible. The unusual co-president structure was hardly Business 101, and many observers figured the new team wouldn't last. Few believed co-presidents could survive the inevitable political maneuvering and clash of egos.

SUCCESSION SWEEPSTAKES?

No matter what else Knight intended, it also looked very much as if he had set up a horse race among those most likely to succeed him. Knight, who owns 80% of Nike's voting stock, and about 36% of the common shares, has never said when or even if he will retire or what will happen to his voting stock on his death. Speculating on his eventual departure has been the topic of water-cooler conversations for nearly a decade. The succession issue remains the single biggest question at the company, although the new management structure has gone a long way toward assuring investors that the bench is deep.

Possibly because there was little time for politicking or backstabbing, given Nike's plight, Parker, Denson, and the rest have mostly steered clear of those pitfalls and focused on shoring up Nike's weaknesses. "There are aspects of this culture that are incredibly powerful and strong," says Parker, citing design and marketing. "But we needed to get after the basic pieces of the business: operating principles, financial management, supply-chain renovation, and inventory management."

In the old days at Nike, the culture encouraged local managers to spend big and to go flat-out for market share instead of profitability. In Paris, for instance, the company spent lavishly for a soccer park at the 1998 World Cup to promote itself. Analysts estimate, conservatively, that it was more than $10 million over budget. The cost, which Nike never disclosed, caused Wall Street to start asking whether anyone was in charge.

So Parker and Denson engineered a matrix structure that breaks down managerial responsibility both by region and product. Because the company pumps out 120,000 products every year in four different launch cycles, local managers always had plenty of choice -- but also plenty of ways to screw up. Under the matrix, Nike headquarters establishes which products to push and how to do it, but regional managers are allowed some leeway to modify those edicts. The matrix won't guarantee that another fiasco like the Paris soccer park cannot occur, but it makes it a lot less likely.

FILLING THE ORDERS

Nike also overhauled its supply-chain system, which often left retailers either desperately awaiting delivery of hot shoes or struggling to get rid of the duds. The old jerry-built compilation strung together 27 different computer systems worldwide, most of which couldn't talk with the others. Under Denson's direction, Nike has spent $500 million to build a new system. Almost complete, it is already contributing to quicker design and manufacturing times, and fatter gross margins -- 42.9% last year, up from 39.9% five years ago. Nike says that the percentage of shoes it makes without a firm order from a retailer has fallen from 30% to 3%, while the lead time for getting new sneaker styles to market has been cut to six months from nine.

Meanwhile, Nike has started paying serious attention to its handful of acquisitions, once treated as more of an afterthought. After buying up Cole Haan almost 15 years ago, Nike struggled to add any real value at the dress-shoe outfit. But lately, Nike managers have figured out that by giving their acquired brands some independence, rather than forcing Nike's testosterone-laced corporate culture on them, they can achieve better results. "We've learned to let those brands pull resources and expertise out of the mother ship as opposed to pushing the mother ship onto the brands," Blair says. Nike doesn't break out results for each sub-brand, but the group's sales grew 51%, to $1.4 billion last year. With nearly a quarter of the sales growth, Converse was the star.

That still-modest portfolio of different brands helps to lessen the company's dependence on hit shoes and could help Nike turn in a more consistent performance. That's why Nike is eager to snap up complementary brands as they become available. In mid-August it paid $43 million for Official Starter Properties, licensors of sneakers and athletic apparel whose brands include the budget-level Shaq label. "What we're trying to do is move toward more of a consumer, noncyclical model," says Blair. "The key is trying to find the right balance of discipline, innovation, creativity, and structure."

Nike has also had to grapple with the touchy topic of sweatshop labor at the 900-odd independent overseas factories that make its clothes and sneakers. When Nike was getting pummeled on the subject in the 1990s, it typically had only two responses: anger and panic. Executives would issue denials, lash out at critics, and then rush someone to the offending supplier to put out the fire. But since 2002, Nike has built an elaborate program to deal with charges of labor exploitation. It allows random factory inspections by the Fair Labor Assn., a monitoring outfit it founded with human rights groups and other big companies, such as Reebok International Ltd. and Liz Claiborne Inc., that use overseas contractors. Nike also has an in-house staff of 97 which has inspected 600 factories in the past two years, grading them on labor standards. "You haven't heard about us recently because we have had our head down doing it the hard way. Now we have a system to deal with the labor issue, not a crisis mentality," says Maria S. Eitel, Nike vice-president for corporate responsibility.

It's overseas, in fact, where most of Nike's sales now come from. Last year, for the first time, international sales exceeded U.S. sales -- still the company's single largest market. Under Grossman, Nike is making sports fashion a core business, something unthinkable until recently inside Nike's male-dominated culture. Thanks to stylish athletic wear -- think tennis star Serena Williams at the U.S. Open -- Nike's worldwide apparel sales climbed 30% in three years, to $3.5 billion in fiscal 2004.

Of course, Nike still faces challenges. After several years of red-hot growth, European sales of higher-priced shoes have started to slide. In the U.S., retro-sneaker makers like K-Swiss, Diesel, and Puma are filling a rising demand. And adidas-Salomon has redoubled efforts to attack the North America basketball market, where Nike has a 60% share. Taking a leaf from Nike's book, Adidas just signed three NBA all-stars: Tracy McGrady, Tim Duncan, and Kevin Garnett, each of whom will have his own sneaker. On the technology front, Adidas has unveiled the Adidas 1, a $250 shoe slated for December that has a computer chip that automatically adjusts the fit as the wearer runs.

Nike aims to keep pace in the techno-battle with Nike Free, a shoe still being tested, that makes runners feel as if they were barefoot. It's inspired by the barefoot runners of Kenya, who have proved that shoeless training builds strength and improves performance. Meanwhile the company continues to refine its Shox technology -- a special cushioning system first developed for runners, which is now becoming a top seller in categories from running to basketball to cross training. The shoes, which sell for up to $135 a pair, helped put to rest the idea that high-priced sneakers no longer sell well in the U.S.

SWIFTEST KICK

Nike has also shown it can grow by expanding into new markets. When the U.S. hosted the World Cup in 1994, Nike's global soccer sales were $45 million. But a team of executives persuaded Knight that soccer was the company's future. Today, soccer sales are nearly $1 billion, or 25% of the global market. This year, for the first time, Nike's share of the soccer shoe market in Europe, 35%, exceeded Adidas, at 31%. Nike has achieved that fast growth in part by using the same outsize marketing tactics that made it big in the U.S. It paid the prestigious Manchester United club an unprecedented $450 million over 14 years to run its merchandising and uniform operation.

Just before this summer's European soccer championships, Nike launched its Total 90 III, a sleek shoe that draws inspiration from cars used in the Le Mans 24-hour road race. Nike realized that millions of kids around the globe play casual pickup soccer games in the street and developed the shoe especially for them. That insight does not impress soccer purists. "Nike is selling a lot of the Total 90 street shoes and is including them in the soccer category," huffs Adidas CEO Herbert Hainer. "They are trying to turn the business model into a lifestyle." He's right, of course. Just as Nike made basketball shoes into an off-the-court fashion statement, its Total 90s have become fashion accessories for folks who may never get closer to a soccer pitch than the stands.

What's the lesson? Let other companies worry about the traditional boundaries between sport and fashion. Nike has built its empire by transforming the technology and design of its high performance sports gear into high fashion, vastly expanding its pool of potential customers. If competitors want to get hung up on what exactly Nike's selling, that's O.K. with the folks in Beaverton. It's all Nike to them.

By Stanley HolmesWith Aaron Bernstein in Washington


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